The Intelligent Investor

Best & Worst ETFs & Mutual Funds: Materials Sector

The Materials sector ranks sixth out of the ten sectors as detailed in my sector roadmap. It gets my Neutral rating, which is based on aggregation of ratings of 11 ETFs and 11 mutual funds in the Materials sector as of April 16, 2012. Reports on the best & worst ETFs and mutual funds in every sector and style are on my blog and the Trading Deck.

Figure 1 ranks from best to worst the nine Materials ETFs that meet our liquidity standards. Figure 2 shows the five best and worst-rated Materials mutual funds.

To identify the best and avoid the worst ETFs and mutual funds within the Materials sector, investors need a predictive rating based on (1) stocks ratings of the holdings and (2) the all-in expenses of each ETF and mutual fund. Investors need not rely on backward-looking ratings.

The best ETFs and mutual funds allocate more value to Attractive-or-better-rated stocks than the worst, which allocate too much value to Neutral-or-worse-rated stocks.

Investors should not buy any Materials ETFs or mutual funds because none get an Attractive-or-better rating. If you must have exposure to this sector, you should buy a basket of Attractive-or-better rated stocks and avoid paying undeserved fund fees. Active management has a long history of not paying off.

Figure 1: ETFs Ranked from Best to Worst

* Best ETFs exclude ETFs with TNA’s less than 100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

PowerShares Dynamic Basic Materials [s: PYZ] is excluded from Figure 1 because its total net assets (TNA) are below $100 million and do not meet our liquidity standards.

Figure 2: Mutual Funds with the Best & Worst Ratings – Top 5

* Best mutual funds exclude funds with TNA’s less than 100 million for inadequate liquidity.

Sources: New Constructs, LLC and company filings

iShares S&P North American Natural Resources Sector Index Fund  [s: IGE] is my top-rated Materials ETF and  Fidelity Select Portfolios: Fidelity Advisor Materials Fund [s: FMFEX] is my top-rated Materials mutual fund. Both earn my Neutral rating.

SPDR S&P Metals & Mining ETF [s: XME] is my worst-rated Materials ETF, and ICON Funds: ICON Materials Fund [s: ICBAX] is my worst-rated Materials mutual fund. Both earn my Dangerous rating.

Figure 3 shows that 45 out of the 237 stocks (over 28% of the total net assets) held by Materials ETFs and mutual funds get an Attractive-or-better rating. However, none of the 11 ETFs and 11 mutual funds in the Materials sector get an Attractive-or-better rating.

Mutual fund managers allocate too much capital to low-quality stocks. Materials ETFs hold poor quality stocks.

Figure 3: Materials Sector Landscape For ETFs, Mutual Funds & Stocks

Sources: New Constructs, LLC and company filings

Again, investors should not buy any materials ETFs and mutual funds. Instead, they should focus on individual holdings.

Freeport-McMoRan Copper & Gold, Inc. [s: FCX] is one of my favorite stocks held by Materials ETFs and mutual funds and earns my Very Attractive rating. FCX’s ROIC of 16% puts it in the top 14% of companies. FCX’s current valuation at $36.94 implies a permanent 40% decline in profits. The strength of GD’s business and low expectations for future profitability make its risk/reward appealing to investors.

Alcoa Inc. [s: AA] is one of my least favorite stocks held by Materials ETFs and mutual funds and earns my Dangerous rating. AA has a long history of destroying value for shareholders, with negative economic earnings in 13 of the last 14 years. AA’s current stock price of $9.85 implies that the company will be able to grow profits by 4.7% annually for the next 30 years. I think the valuation is too high and there is too much downside in the stock.

157 stocks of the 3000+ I cover are classified as Materials stocks, but due to style drift, Materials ETFs and mutual funds hold 237 stocks.

As detailed in “Cheap Funds Dupe Investors”, the fund industry offers many cheap funds but very few funds with high-quality stocks, or with what I call good portfolio management.

Figures 4 and 5 show the rating landscape of all Materials ETFs and mutual funds.

Our sector roadmap report ranks all sectors and highlights those that offer the best investments.

Figure 4: Separating the Best ETFs From the Worst ETFs

Sources: New Constructs, LLC and company filings

Figure 5: Separating the Best Mutual Funds From the Worst Mutual Funds

Sources: New Constructs, LLC and company filings

Review my full list of ratings and rankings along with free reports on all 11 ETFs and 11 mutual funds in the Materials sector.

Disclosure:  I receive no compensation to write about any specific stock, sector or theme.

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Trainer brings insight and transparency to research on stocks, ETFs and mutual funds.

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David Trainer

Trainer brings insight and transparency to research on stocks, ETFs and mutual funds.
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